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WASHINGTON, DC - NOVEMBER 30: U.S. Speaker of the House Rep. John Boehner (R-OH) speaks during a news conference November 30, 2012 on Capitol Hill in Washington, DC. Speaker Boehner held a news conference to respond to President Barack Obama on the fiscal cliff issue saying 'There is a stalemate. Let's not kid ourselves.' (Image credit: Getty Images via @daylife)

The devastating impact of Hurricane and Superstorm Sandy particularly resonates with me, a near lifelong resident of New Jersey. My heart goes out to those whose lives were literally turned upside down by the storm.

Now we're dealing with the year-end fiscal cliff which could lead to Hurricane Sandy’s financial analog, a Black Swan event. In this column I explore what’s involved in creating a “hurricane proof” portfolio - one that can withstand a Black Swan and remain relatively intact.

First, I am duty bound to say that no investment strategy exists that will enable clients to avoid all of the downside and participate fully on the upside. However, I believe several key financial principles can provide investors with a strong defensive portfolio able to withstand a Black Swan and ultimately recover any losses, and I will discuss specific investments that I believe correspond well to those financial principles.

Diversification remains a staple of investing, but it is not sufficient. When I analyze the benefits of diversification, I look beyond historical correlations and style boxes. Instead, I focus on different return drivers, such as stock market returns, commodity prices, interest rates, credit risk, and yield. For example, my firm recommends Eaton Vance Parametric Structured Commodity Strategy Fund (EIPCX), with its obvious driver being commodity prices.

Liquidity is another investment principle that is often taken for granted - at least until something goes wrong. In reality, relatively few investments - private equity is one - require long-term lockups. A hedge fund trading predominately listed equities has no client-centric reason to have a one-year lockup. If a Black Swan quickly emerges from the shadows, it is of great value to be able to redeem an investment quickly.

Transparency was once almost an afterthought in the financial world until the word “Madoffed” entered the financial lexicon. Financial fraud aside, transparency provides other benefits. For example, transparency into an investment provides advisors with a better understanding of how a particular investment fits in a client’s overall portfolio. The Permanent Portfolio (PRPFX) is a fund recommended by my firm that provides excellent transparency. The fund gets its name from a relatively static asset allocation among various asset classes - stocks, bonds, gold, silver, and Swiss Francs - that is rebalanced annually.

Low Fees is another investment principle routinely championed by John Bogle of Vanguard. In a competitive and relatively efficient market, low fees can make a big difference over time. In a nod to John Bogle and Vanguard, my firm recommends the Vanguard Total Stock Market ETF (VTI). This ETF boasts an amazingly low expense ratio of 5 basis points. It can afford to charge such as low fee since the ETF has in excess of $200 billion in assets.

Downside Protection is also an essential element in the construction of a portfolio designed to withstand Black Swan events. There are several ways to secure downside protection, and conventional wisdom prescribes the use hedge funds. However, few hedge funds in the world can guarantee a specific amount of downside protection. Options may also be used to effectively reduce downside risk. My firm, Risk 3.0 Asset Management, developed an strategy that uses a combination of options and ETFs to protect the first twelve percent of losses for the SPY. It also enhances returns on the upside at twice the rate of SPY, up to a maximum return, or price cap (before management fees).

Investors who seek to surpass rates of inflation must step out further on the ledge of risk, and, clearly, all risk is not created equal. I believe that investors can be significantly protected from losses, but still retain attractive upside potential by following the investment principles listed is this article. Namely, diversification, liquidity, transparency, low fees, and downside protection.